Futures hope for Black Sea contracts
January 01, 2005
by World Grain Staff
by Si Matthies
Alexey Ivanov sits in his comfortable office in the corporate headquarters of the Razguliay-UKRROS Group, a diversified agribusiness firm located in Moscow, Russia. Alexey Ivanov is managing director of the Razguliay-Zerno (Grain) Co. With a reduced 2003 crop and intense competition in a milling industry that is operating at less than half of daily capacity, margins are a problem.
Extreme price volatility, tight merchandising margins and a mid-year government intervention into the market due to the short crop, have made for a difficult, high-risk year. The outlook for the coming year has improved, with crop winterkill minimal, adequate moisture conditions and an overall brighter picture for total wheat production in 2004.
Igor Potapenko, chairman of the board of the Razguliay Group, has asked Alexey Ivanov for his operating plan for handling and marketing this coming crop year’s flour and grain activities. With warehousing space of over 1.8 million tonnes, 1,500 tonnes of flour milling daily capacity and more than 1,500 tonnes of feed milling daily capacity, Alexey Ivanov is reviewing his plans.
There is a good crop coming on, flour customers are willing to commit into the new crop year and foreign wheat customers are willing to book out into the new crop. Also, producer customers want to lock in some reflection of current market prices (late spring 2004) for the new crop.
Alexey Ivanov has a dilemma: how does the company capitalize on the present opportunities without taking excessive price risk in what is at best an ill-defined market? How does he assure customer contract performance — an ongoing problem? How should he allocate his available warehousing space inland and at his modern export terminal located on the Azov Sea to satisfy the needs of his producer customers, assure a profitable flour business and put his limited available working capital to its most productive use?
Alexey Ivanov’s situation is not unique. In another country of the Black Sea basin, Teodor Ivanov (no relation) is sitting in his small, well-appointed office in Sofia, Bulgaria. He is responsible, among other duties, for marketing the production of more than 10,000 hectares of the family owned, highly diversified Agrotime JSC farming enterprise. With half of the land committed to the production of high quality milling wheat and a good crop on the horizon, Teodor Ivanov is frustrated by his inability to price forward and lock in margins on at least a portion of the farm’s wheat production for the upcoming year. "The Chicago Board of Trade no longer reflects the situation in our region," he complains. With a Black Sea futures contract, grain producers, processors, animal farmers, traders and speculators would be able to optimize the process of deciding when to sell or buy and what to produce, he told World Grain.
The need for an early source of work- ing capital exacerbates the problem, because Teodor Ivanov is unable to show his banker contracts that would ease his questions regarding returns on the upcoming crop. The fact that he is unable to sell forward into the new crop year and assure the company of much needed working capital early in the new harvest season or satisfy their banker’s needs, are an ever increasing source of concern for their diversified and expanding operations. NEED FOR MARKETING MECHANISMS These and similar operating issues are repeated throughout countries bordering and branching out from the Black Sea basin. With the exception of Turkey, government price intervention in the region has been limited, requiring producers and the trade to look to the market place for their crop pricing and future price indicators. These price signals are few and far between until well into the new crop year.
With the region becoming a significant factor in the world wheat markets there is an acute need for improved marketing mechanisms such as wheat futures and options to provide much needed marketing tools for the grain and flour industry.
A recent project, funded by the U.S. Agency for International Development (USAID), concluded that establishing a successful futures contract representing trade in the Black Sea Region is not only feasible but also highly desirable, badly needed and eagerly anticipated by the grain trade.
CHALLENGES AHEAD There are issues to be resolved in order to make this a reality, notably the need for an improved real-time market information system, the need for extensive education programs addressing the benefits and uses of futures markets and a mechanism for satisfying delivery against the futures contract.
The trade has expressed concern about contract performance and a safe, secure delivery mechanism. Considerable work has already been done in the region on the setting up warehouse receipt systems. Several have been established with underlying indemnity funds to assure performance; others are in the development stage. Add to this the margining and financial safeguards that can be built into an exchange system and there is little doubt that the contract performance concern can be minimized.
Since well-defined, reliable cash market quotes are not available, cash settlement is not an alternative.
The points for delivery are open for discussion, depending on the interests and desires of the various exchanges that have indicated an interest in developing the contract. Logically, it would appear that the delivery should be based on the export markets, which are also reflected in the domestic markets of the countries within the region.
Three locations offer good potential: the mouth of the Danube River, with tributary points up river being logical alternative delivery points; export locations in Russia, with delivery points in the interior primary wheat area and lastly, delivery points in the Ukraine, set up in a similar fashion to Russia. Some combination of the above may also be a viable alternative. INTEREST FROM EXISTING EXCHANGES Many existing exchanges in the region and internationally have expressed an interest in establishing a futures contract.
The Budapest Commodity Exchange (BCE) has had an operating futures market in agricultural commodities since 1989. It has recently modified its existing wheat contract to conform to E.U. requirements and has increased its delivery points. The exchange has expressed an interest in the development of Black Sea-based futures in conjunction with accession into the E.U. of additional countries that have access to tributaries to the Danube River and Black Sea.
The Chicago Board of Trade (CBOT) is currently conducting research to de- termine if its experience and history in providing risk management tools and price discovery for the world grain markets can be utilized to increase the efficiency of the markets in the Black Sea region.
The Moscow International Currency Exchange (MICEX), the largest domestic exchange for the rapidly growing Russian stock market and its smaller domestic sister exchange, the National Mercantile Exchange (NAMEX), have been active in the development of agricultural futures contracts based on the experience gained through carrying out state grain intervention auctions. They are currently in the process of developing a wheat futures contract.
Several of the smaller operating exchanges in the region have also indicated a strong interest and support for the development of a wheat futures contract representing the Black Sea region.
One of the foremost experts on Russian agribusiness is Dr. Dmitri Rylko. Based in Moscow, he is director of the Institute for Agricultural Market Studies, a consulting, analytical and market information agency. "Many in the domestic grain trade give a pessimistic view on the potential for a Russian wheat futures, often referring to the yet under-developed cash market," he told World Grain. "The truth is that in the modern world we would never have a strong cash market without an underlying futures. The idea of a Black Sea future looks especially attractive, as it mitigates the ‘cons’ and capitalizes on the ‘pros’ of numerous individual countries of the region."
The final structure and direction of the development of a wheat futures contract is in the early formative stages and therefore it is premature to speculate where, when and who will develop a successful contract.
There are many issues to be resolved, but none that are insurmountable. All signs point to the establishment of a successful wheat futures contract representing the wheat trade in the Black Sea Basin in the near future. WG
Si Matthies is a former director of Grain Operations, General Mills Inc. He was a member of the three major U.S. agricultural exchanges for more than 30 years and served as a member of the board of directors of the Chicago Board of Trade and the Minneapolis Grain Exchange. Since retirement in 1990, he has been supporting the public and private development of the grain marketing and flour-processing infrastructure throughout the developing world. He welcomes article comment and can be contacted at firstname.lastname@example.org. We want to hear from you — Send comments and inquiries to email@example.com.